The commodities supercycle was over, investors were losing interest and regulators were clamping down on risky trading. Most banks were retreating from commodities, but not Goldman Sachs Group Inc.
“That is a core, strategic business for us,” Chief Executive Officer Lloyd Blankfein said in a 2013 interview with CNBC.
Four years on, and Blankfein’s insistence that the commodities division — where he cut his teeth — would eventually return to previous levels of profitability is beginning to waver. Isabelle Ealet, a co-head of the bank’s securities division, is leading a review of Goldman’s commodity division after its worst start to the year in more than a decade, people familiar with the matter told Bloomberg.
The decline in profitability is a blow for a unit that for decades has dominated global commodity markets — becoming known, along with Morgan Stanley, as one of the “Wall Street refiners.”
“The world changed a little bit: We have less volatility, less trending markets,” said Goran Trapp, founder of boutique advisory firm Energex Partners and former global head of oil trading at Morgan Stanley. “As banks have dismantled the merchant aspect of their business model, they have reduced the areas where they can generate income.”
“Commodities has been and still is an important business for our clients and we will continue to invest in it to ensure we are best meeting their needs,” Michael DuVally, a Goldman spokesman, said in an emailed statement.
Goldman’s history in commodities stretches back more than three decades to its 1981 purchase of J. Aron, an agriculture and metals trader that had been founded in 1898 to import coffee to New Orleans.
The unit was a hothouse for some of the rising stars of the commodities business. Marco Dunand and Daniel Jaeggi, co-founders of Mercuria Energy Group Ltd., worked there. So did Stephen Hendel and Stephen Semlitz, co-founders of Hartree Partners LP. So did many of Goldman’s own top executives: from Blankfein and Ealet to Chief Financial Officer Marty Chavez and co-head of investment management Tim O’Neill. President Donald Trump’s chief economic adviser, Gary Cohn, also worked at J. Aron.
With the creation of the Goldman Sachs Commodity Index, the bank helped to popularize commodity investing as a China-led boom in demand led prices to skyrocket.
Profits also surged at Goldman Sachs: Its commodity unit’s revenues rose from less than $500 million a year before 2000 to average over $3 billion a year between 2006 and 2009 and hit a peak of $3.4 billion in 2009, according to a Senate report on banks’ involvement in the physical commodity markets.
Commodities accounted for as much as 17 percent of the revenues of the securities division and made average margins of 60 percent, the bank said in an internal presentation in October 2011, published as part of the Senate investigation.
But that presentation also hinted at looming problems for the bank. “In the last 2 years, margins and market share have declined dramatically as a result of increased competition,” it said. Tougher regulation, including the Volcker Rule limiting speculative trading by banks, was another challenge.
From 2010 through 2014, the commodities business’s contribution to the trading division’s revenue had dropped to an average of 8 percent, according to a February 2015 presentation. That was the least of eight businesses.
Other banks cut back. Morgan Stanley sold its oil trading business in 2015 and JPMorgan Chase & Co. shed a big part of its physical commodities business in 2014; Barclays Plc and Deutsche Bank AG also shrank their businesses.
Goldman sold a metals-warehousing unit and coal mines that had attracted regulatory and political scrutiny. But it remained committed to commodities, hoping to ride out the storm and be left with a less competitive environment — much as it had in the 1990s and early 2000s, when together with Morgan Stanley it dominated the commodities industry.
But profitability in commodities has continued to decline, even as Goldman’s rivals stepped back. Combined revenues at major investment banks fell to $4.3 billion last year from $8.3 billion in 2011, according to Coalition Development Ltd., a London-based analytics company.
And revenues have fallen further this year at Goldman, according to a person familiar with the matter. One reason is low volatility — especially in the oil market — that makes companies and investors less inclined to undertake large trades.
“Unless and until volatility returns to the commodities market, we do not expect commodities trading to be a major focus of Goldman Sachs,” said Robert Pease, a Bracewell LLP attorney who has spent decades in the energy markets.
Another reason is the regulatory restrictions on speculative and physical trading that have reduced the range of opportunities available to banks.
Goldman’s commodity business by the mid-2000s was overwhelmingly focused on financial markets, thanks to the growing importance of investors in commodity markets. By 2009, the bank traded 3.5 billion barrels of crude oil derivatives in a year — more than 200 times what it traded physically, according to data released as part of the Senate investigation.
But growing competition from rivals including JPMorgan and Citigroup pushed Goldman to expand into physical commodities — and to invest in assets including coal mines in Colombia and metal warehouses.
With those investments came political scrutiny. A U.S. Senate panel investigated the role of banks in physical commodity markets after beer makers complained that long wait times for metal deliveries from warehouses owned by Goldman had pushed up their costs. Then last year, the Federal Reserve proposed rules that would sharply increase the cost of banks’ physical commodities operations.
Now, a greater portion of investment banks’ commodities revenue is coming from more liquid and transparent products — and generally less profitable — such as jet fuel hedges for airlines, or simple natural-gas swaps, according to an ex-Wall Street trading executive who asked for anonymity so that he could speak freely.
“It’s back to how it was in the mid-90s where it was just a client intermediation, risk management focus,” Trapp said.
Goldman may yet decide that its initial instinct was correct and continue waiting for a rebound in the commodities business. Or it may shrink its commodities division — much as its long-time rival Morgan Stanley has done.
“The low-volatility environment that we’re in now is unprecedented and unlikely to persist,” says Craig Pirrong, a business professor at the University of Houston. “This would probably be the wrong time to get out.”